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Summary
Introduction 6
1. When was IFRS 10 published and what is the mandatory effective date? 7
2. Does IFRS 10 replace other standards or interpretations? 7
3. What was the IASBs main objective? 8
4. Will IFRS 10 help to bring about convergence with US GAAP? 9
5. What is the new definition of control? 10
6. What new concepts are introduced in IFRS 10? 11
7. Must the purpose and design of the entity be taken into account, and if so,
how? 11
8. What are the definitions of substantive rights and protective rights?12
9. In practice, what elements should be considered when assessing whether or
not rights are substantive?13
10. In practice, what types of rights should be deemed protective rights?14
11. What is the difference between an agent and a principal (the concept of
delegated power)? 15
12. Are there any situations in which it is not necessary to take all these indicators
into account when assessing whether an investor is an agent or a principal? 17
13. How do you identify a de facto agent?18
14. How should franchises be dealt with?18
15. What are relevant activities? 19
16. How should an investor assess shared authority over relevant activities?20
17. What is the definition of a silo?20
18. What is the definition of power?21
19. What elements should be taken into consideration when assessing the level of
power over the entitys relevant activities? 22
20. What should an investor do in practice when voting rights are conclusive in
determining power? 22
21. What is the definition of de facto control? 23
22. How should an investor assess whether de facto control exists? 24
23. How should call options and other potential voting rights be taken into
account?25
24. What elements should be taken into account when assessing power if voting
rights are not substantive?25
25. What are the main indicators for assessing the investors practical ability to
direct the entitys relevant activities? 26
26. If the above are not conclusive, what are the additional indicators? 26
27. What does IFRS 10 mean by special relationship? 27
28. In what situations should a large exposure to the variability of the entitys
returns be taken into account? 27
29. What is the definition of returns? 28
30. Is the concept of returns linked to a specific threshold? 29
31. But is there a de minimis threshold, below which the returns criterion would
probably not be met? 29
32. How should an investor assess whether it has the ability to use its power to
affect its rights/exposure to variable returns (i.e. whether there is a link between
power and returns)? 29
33. What are the steps to be followed when
applying IFRS 10? 30
34. Generally speaking, what elements should be examined in order to determine
whether the investor has the ability to direct the entitys relevant activities? 31
35. What are the rules on initial application of IFRS 10? 32
36. What are the requirements under IFRS 10 if there is no change in the level of
control? 34
37. What is the procedure for first-time consolidation linked to initial application of
IFRS 10? 34
38. What is the procedure when the group no longer controls an entity under IFRS
10? 35
39. Which sectors are likely to be the most affected?35
40. What are the key points to remember about IFRS 10? 36
Notes 38
Introduction
IFRS 10, which was published in May 2011, introduces a single definition of
control and replaces the portion of IAS 27 which related to consolidated financial
statements, as well as the SIC 12 interpretation on special purpose entities.
According to the IASBs schedule, the new standard is effective from 2013 for
entities with a reporting date at the end of the calendar year.
It may change the scope of consolidation (i.e. which entities should be
consolidated) but the consolidation techniques remain the same (i.e. how
to carry out consolidation).
In addition to the new definition of control, IFRS 10 includes clarifications on
various issues which were not previously addressed by the IFRS framework,
including:
the difference between protective rights and substantive rights;
de facto control;
the difference between an agent and a principal;
the concept of silos.
IFRS leaves a large amount open to professional judgement, particularly as
regards potential voting rights (e.g. call options).
Given the potential difficulties in applying this standard, it is essential that
all stakeholders familiarise themselves with it quickly particularly preparers
of financial statements, auditors and regulators.
To help with this, we have prepared the following series of 40 questions and
answers.
The standard is quite short (the main body of the standard is only five pages
long, supplemented by a useful 38-page application guide) and leaves a large
amount open to professional judgement. As a result, there is likely to be plenty
of discussion between entities, their auditors and the regulators.
3. WHAT WAS THE IASBS MAIN OBJECTIVE?
By introducing a single definition of control, the IASB wanted to make it easier
to assess control without needing to know whether the entity fell within the
scope of SIC 12.
Readers will remember that the current definition of control under IAS 27
(the power to govern the financial and operating policies of an entity so as
to obtain benefits from its activities) primarily focuses on the ability to take
strategic decisions relating to the entitys operations or financing. In contrast,
SIC 12 is based upon an evaluation of risks and rewards
ED10 proposed a single definition of control but, as it attempted to bring
IAS27 and SIC 12 together into a single standard, it dealt with special purpose
entities (referred to as structured entities) separately. This was felt to be
inconsistent with the goal of introducing a single definition of control.
In response to the criticisms, the IASB has introduced a single definition
of control in IFRS 10 which is applicable in all cases, for both traditional
subsidiaries and special purpose entities, with no distinction between the
different types of entity.
Power
Returns
Link
between
power and
returns
Control must be
continuously
reassessed!
Control
11
13
To be considered substantive,
rights must be exercisable when decisions
on relevant activities are made.
Substantive rights
Whether or not the rights holder would benefit may also depend on
whether significant synergies would be possible (if the rights were
exercised), as the concept of returns is broader than the concept
of benefits as in IAS 27 (cf. question 29).
15
al
f remov
Right o use by a
ca
without
ent
rty ag
a
p
le
sing
Scope of
authority
Exposure to
variability of
Relative magnitude?
returns
Variability?
Are interests in line with those
of other investors?
16
Other
parties
rights
Removal
rights?
Liquidation rights?
Type of
remuneration
arket
Non m
ration
e
n
u
rem
ipal
c
n
pri
17
19
Thus, according to the definition of control given in IFRS 10, power arises
from rights and it is not necessary to have actually directed activities in order
to have control (the ability to direct activities is sufficient).
The exercise of power thus involves identifying relevant activities (cf. question15),
how decisions are made about these relevant activities, and what are the rights
over the entity held by the investor and by other parties.
However, only substantive rights (cf. question 9) are taken into account in the analysis,
not protective rights (cf. question 10).
21
The standard also addresses situations where the entitys relevant activities
are actually directed by the government, a court, a regulator or a liquidator,
in which case the investor which holds the majority of the voting rights does
not have power over the entity.
In some sectors, such as defense, a foreign majority shareholder may be required to
transfer its voting rights to independent citizens of the country in which the entity is
based. These citizens must exercise their rights in order to protect the entity from any
external influence.
23
If an assessment of the first three indicators is not conclusive, then all the
facts and circumstances must be taken into consideration.
In this case, the investor must assess (a) the indicators which shed light
on the investors practical ability to direct the entitys relevant activities (cf.
question25) and, if necessary, (b) additional indicators (cf. question 26).
Although these various indicators are more generally used in the case of structured
entities, it may sometimes be necessary to use them in the case of traditional entities.
25
Many commentators criticised the fact that ED10 proposed a differentiated approach to
control, noting that this was not consistent with the Boards objective of introducing a single
definition of control which would apply to both traditional and special purpose entities.
26
27
29
30
Structured entities
Q.23
De facto control
Q.22
Q.7
Practical ability
to exercise power
Q.25
Special relationship
Q.27
Level of exposure
to variability of returns
Q.28
31
Special relationship
Do nothing
No
Deconsolidation
Mandatory for
financial periods
commencing on or after
1 January 2013
Is a business
(as defined in IFRS 3)
IFRS 3
Is not a business
IFRS 3 (but no goodwill)
Subject to adoption
by the EU!
33
IFRS 3 shall therefore be applied at the deemed acquisition date. However, if the
entity is not a business (as defined in IFRS 3), no goodwill can be recognised.
As the standard is generally to be applied retrospectively, this raises questions over
which version of IFRS 3 should be used. This is a significant issue, due to changes in
the definition of a business.
Readers will remember that the revised IFRS 3 (published in 2008) was prospectively
applicable (i.e. for business combinations taking place in financial periods starting on
or after 1 July 2009).
The amendment published on 28 June 2012 clarifies that IFRS 3 (2008) must be used if
control was obtained later than the effective date of IFRS 3 (2008). If control was obtained
before that date, an entity can apply either IFRS 3 (2004) or IFRS 3 (2008).
35
40. WHAT ARE THE KEY POINTS TO REMEMBER ABOUT IFRS 10?
The key points to remember about IFRS 10 are as follows:
1. A single definition of control, which applies to both traditional
entities (subsidiaries of industrial and commercial groups) and
structured entities (special purpose entities and similar entities).
2. Control implies (a) power over the relevant activities, (b) exposure
(positive or negative) to variable returns, and (c) the ability to use
this power to affect the amount of these returns.
3. The concept of benefits is replaced by the much broader concept
of returns, which includes returns that are specific to that
investor (such as synergies, economies of scale or access to scarce
products).
4. Several additional clarifications on (a) substantive and protective
rights, (b) the distinction between an agent and a principal, (c) de
facto control, and (d) silos.
5. The accounting treatment for call options and other potential
voting rights is potentially very different (and is largely left open to
professional judgement).
6. The level of control must be reassessed regularly, especially if facts
and circumstances indicate that there may be changes to any of the
three criteria mentioned in point 2 above.
7. There is no official threshold above which consolidation is
required (when assessing the criterion which relates to exposure
to variable returns). However, the examples suggest an implied
threshold of around 20% (above which the exposure to variable
returns criterion is deemed to be met).
37
38
Notes
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